The ACH Has Yet to Become a Serious Alternative for Check Payments

March 1986

Despite nearly two decades of growth and promise, the ACH has yet to become a serious alternative for check payments

Pamela S. Frisbee

Predictions of a cashless society were common- why electronic payments have yet to be as place in the 1950s and 1960s when plastic widely accepted as forecasters had predicted. cards seemed to be taking over the world and Our contributors also look at what is likely to major advances in electronic technologies prom- happen to the ACH in the future. ised to make all things possible. But today, An automated clearinghouse is a payment neither checks nor currency plays a less signifi- mechanism through which participating depos- cant role in our economic life than two or three itory institutions exchange funds electronically, decades ago. Public subsidies to the check thus creating an alternative to the common processing system, the relatively high cost of method of transacting payments with checks. electronics, and the structure of this country's The ACH replaces the check with a series of financial services sector all have served to electronic impulses transmitted over data links retard the development of electronic payments, or, more commonly, by magnetic tapes or despite their potential for increasing the effi- floppy disks. Participants in the clearinghouse ciency of the entire system and the convenience use a common format for coding information they offer to consumers and other individual and abide by operating rules of the National users. Electronic funds transfer (EFT) in the Automated Clearing House Association (NACHA) form of direct debits at the point-of-sale, home and regional associations. Automated clearing- banking, and automated clearinghouse (ACH) house associations are nonprofit corporations payments has been slow to take hold. The ACH owned by member depository institutions. is the main driving force for most forms of electronic payments; yet its growth has been The ACH grew out of concern that traditional halting and problematic A look at the history of check clearing facilities (which process paper the ACH will lay the groundwork for the rest of items mechanically) would be unable to ac- this special Economic Review, which considers commodate the rapid economic expansion both the ACH's promise and the obstacles to and corresponding increase in check volume its development that characterized the late 1960s. The costs of labor and transportation involved in moving This issue is the first of two that examines paper items were rising rapidly. During the the automated clearinghouse to determine middle to late 1960s, the amount of paper traveling through the check system was increasing at an unprecedented rate, and payments The author is a research analyst on the financial institutions specialists recognized the need for a faster, and payments team at the Federal Reserve Bank of Atlanta. more efficient method.1

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The First Stages of Growth "These additional costs will either reduce profitability, which is already a concern, or increase The ACH is a relatively new payment mech- the expense to our customer. Neither outlook anism compared with other methods in use is attractive"3 today; paper money was introduced in the MAPS recommended two critical areas for Middle Ages and checks were first used in the change: first establishing a clearing and distri- United States in the late 1600s. bution system for electronic payments by the The ACH began in April 1968 when the San banking system, and, second, developing the Francisco and Los Angeles Clearing House full potential of the bank card. The committee Associations authorized the creation of a joint concluded in its 1971 report that automated committee to make recommendations for ex- clearing and distribution facilities should be changing paperless entries among banks. In established locally and linked together nation- August 1970, a group of 10 California banks ally to accommodate paperless debit and credit formed the Special Committee on Paperless transfers. The report emphasized the need for Entries (SCOPE) and obtained approval to industry standards for paperless entries. It also initiate a pilot project, resulting in the computer recommended a comprehensive nationwide software to operate the ACH for interbank clearing and settlement system for electronic paperless entry exchange In August 1972 the payments that would not depend solely on or San Francisco and Los Angeles Clearing House be controlled by the Federal Reserve System. Associations approved the rules and legal agree- This clearing system, according to the report, ments. The Federal Reserve Bank of San Fran- eventually should be able to handle bank, cisco and the Los Angeles Branch provided the corporate, government, and consumer pay- first automated clearinghouse services begin- ments. ning in October 1972. Committee on Paperless Entry. During this Monetary and Payments System Committee. same time the Federal Reserve Bank of Atlanta, Following this regional initiative, a national working with Georgia Institute of Technology, program was set in motion in 1970. In that year, also studied the possibilities of paperless en- the American Bankers Association formed the tries. After this joint research project was com- Monetary and Payments System (MAPS) Com- pleted in September 1971, several major At- mittee to study ways to improve the payments lanta banks formed the Committee on Paper- system by meeting the myriad changes occur- less Entry (COPE). The COPE banks agreed to ring in the financial community. The MAPS implement a Fed-managed ACH, and purchased committee was charged with addressing the software from SCOPE to run it The Georgia need for changes in the existing payments Automated Clearing House became the second system, determining what the changes should ACH, beginning operations in May 1973, just be, and assessing their impact on commercial seven months after the California clearing- banking During this time the banking industry house.4 was affected by three major economic forces: the changing needs of retail and corporate customers, profitability pressures, and mount- Federal Reserve Involvement 2 ing competition in the marketplace The ACH The Federal Reserve Board also played an concept was intended as a natural extension of active part in developing the ACH. The Board the check payment system that would convert stated in 1971 that it supported rapid develop- the growing volume of paper processing at ment of a viable EFT system. It sought to commercial banks and other depository insti- decrease the number of paper items being tutions to electronics, thus responding to some handled, speed settlement by minimizing the of the compelling problems of the day. handling of checks, and reduce commercial The MAPS committee determined that it bank and Fed float resulting from delays. Unlike would be "a costly mistake" for the industry "to the role the MAPS Committee envisioned for remain static with the present payments system Fed involvement in the ACH, the Fed antici- and rely too heavily on the check processing pated playing an active part It viewed its method of funds transfer. Rising labor expenses involvement in the clearing process as neces- will continually expand the relative costs of sary to ensure the safety and soundness of the bank operation," the committee reported. payments mechanism. In the spring of 1972,

FEDERAL RESERVE BANK OF ATLANTA 5

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis March 1986 "The ability to exchange data electronically between regions made it more practical for businesses to use the ACH for the concentration and disbursement of funds."

the Fed agreed to operate clearinghouses for electronically between regions made it more the San Francisco and Los Angeles and the practical for businesses to use the ACH for the Atlanta clearing associations using the software concentration and disbursement of funds, again developed by SCOPE. It would also develop increasing volume and furthering development and operate a nationwide automated clearing and use of the system. facility. The Fed agreed to supply space, equipment and management for the local ACHs, because it felt electronic systems at the local The Monetary Control Act of 1980 level would create "nodes" that the Federal Reserve could then link together through its The Depository Institutions Deregulation and communications network into a national elec- Monetary Control Act of 1980 (hereafter the tronic payments system. Monetary Control Act of 1980) requires the Federal Reserve to price its services, including By 1973 there were 23 SCOPE-type commit- the ACH, at actual operating cost plus a private tees set up across the country. Strong national sector adjustment factor and the cost of the coordination was necessary to achieve the float This charge was included to account for level of compatibility required for interregional costs encountered by a firm in the private and eventually national data interchange. An sector but not by the Federal Reserve (for ACH task force to develop standards for inter- example, income taxes). The Act also allows all regional exchange of ACH entries and to study depository institutions access to Federal Re- educational and marketing possibilities was serve priced services. Previously, Reserve Banks commissioned by the American Bankers Asso- 5 provided these services to members at no ciation. Using the groundwork provided by charge. The pricing provision was designed to the MAPS committee, this task force became improve efficiency of the payments system the forerunner of what is known today as the through increased competition. To encourage National Automated Clearing House Associa- the use of electronics, the Fed priced ACH tion. services not on current volumes and costs, but instead on "mature volumes." This kept the NACHA Arrives on the Scene cost of ACH transactions lower than checks. The subsidy was phased out in progressive NACHA was formed in mid-1974 by local steps and full-cost pricing began January 1, associations to devise national rules and stan- 1986.6 dards, develop educational programs, and pro- vide technical assistance in setting up automated clearinghouses. Eighteen charter members from regional associations representing all Expansion of ACH Services twelve Federal Reserve districts were among The Fed began processing debits during the the original members. night processing cycle in 1979, allowing com- Thirteen ACHs began in 1975, even though panies to concentrate funds. In October 1983 data could be transferred between regions the Fed began processing credits as well as only through the physical exchange of tapes. debits on the night cycle and providing next The federal government began processing Social day settlement Despite a surcharge for using Security payments via the ACH in 1975. The the night cycle, many institutions prefer to take government's participation in direct deposit of advantage of the later deadlines. Social Security payments and, more recently, In 1983, NACHA and the Fed introduced a its use of electronic payments to vendors have pilot program to facilitate corporate trade pay- promoted the ACH. As with any payments ments (CTPs) through the automated clearing- system, volume is a key factor in lowering costs. house. The CTP permits companies to transmit Federal government involvement in the ACH trade payment information such as terms of has substantially increased volume and hence sale and quantity (information similar to that lowered costs, encouraging more development found on an invoice) along with the payment of the system. In September 1978, the Fed These electronic transactions promised to elim- implemented electronic interregional inter- inate a large amount of the paper involved in change, resulting in a truly nationwide clearing- payments. The CTP program was declared a house system. The ability to exchange data success by NACHA expanded and opened up

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Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis March 1986 "Commercial volume. . .has been growing at about 30 to 50 percent each year. Unlike government payments, commercial volume could continue this growth as more corporations sign on."

to any user in January 1984. However, volume Prospects for Greater Volume has been disappointing, running only several hundred transactions per month. Although the number of institutions partici- From just two ACHs in the early 1970s, the pating in the network is growing, the volume number has grown to 31 today, serving over today still falls short of the optimistic outlook 16,000 financial institutions and 34,000 cor- of a few years ago, for several reasons. porations.7 Currently, the network is a nation- Float Float plays an important role in a wide interconnection of ACHs, most of which company's decision whether or not to use the use Federal Reserve facilities for processing, ACH. (Float is the term for the lag between the settlement, and delivery. Much of the recent time a payor writes a check and when it is growth in the number of participants can be actually debited from the payor's account) attributed to new technology, primarily intro- The paying company loses the advantage of duction of the personal computer as an afford- float normally gained from sending payments able means of electronic communication. Thanks through the mail. Often, the loss of float "in- to the multiple uses and low cost of a personal come" created by checks more than offsets the computer compared with a mainframe com- savings that can be expected from using auto- puter, smaller institutions that could not justify mated payments. The opposite is true for the the purchase of a computer for ACH entries in company receiving payments via the ACH; it the past can do so today. benefits as its account is credited the day payment is received rather than several days The ACH now processes approximately 48.1 later when the payment is processed. Currently million electronic payments per month—23.2 there is no way for the receiving institution to million commercial "items," or transfers, and compensate the sending institution for loss of 24.9 million government items. According to float This tends to discourage institutions from Federal Reserve figures, in 1985 the ACH being senders. system handled an estimated 298.9 million government and 278.9 million commercial Check Improvements. Another reason for the transactions for a total of 577.8 million trans- slow growth of the ACH is the low cost of actions.8 Government ACH transactions have processing checks through the check collection been growing by only 10 to 13 percent annually system. Check volume has created economies during the last two years. Growth in government of scale in processing. This, along with the fact volume has slowed mainly because most people that the current collection system becomes who will voluntarily sign up for direct deposit of more efficient each year as equipment that their Social Security payments have already reads and sorts checks improves, reduces the done so. Commercial volume, on the other incentive for financial institutions to invest hand, has been growing at about 30 to 50 time and money to automate payments. Until percent each year. Unlike government pay- ACH volume grows substantially, there is also ments, commercial volume could continue this little incentive from a cost standpoint growth as more corporations sign on. Promotion and Development Promotion ef- As financial institutions begin to market ACH forts by NACHA members of the banking services more aggressively to their customers, 45 ustry, and the Federal Reserve System play the number of participating corporations and dn important role in developing the ACH. consumers will increase. Today there are 34,000 Without good marketing, the likelihood of corporations using the ACH, in contrast with significant growth in transactions is slim even the 3,000 that used the system in 1976. Busi- though direct deposit of funds offers recipients nesses use the ACH to pay employees, as well many conveniences not afforded by traditional as their vendors and suppliers. Consumers use paper checks. Besides removing the danger the system to receive their payroll and Social that a check will be lost or stolen, direct Security checks via direct deposit avoiding deposit offers the recipient the security of long lines at the bank and the possibility of knowing that even if he or she is sick or on losing a check in the mail. Consumers also vacation, the payment still will be deposited. make payments using the ACH; home mortgage To enjoy these advantages, however, the poten- payments, automobile loans, and insurance tial user must be aware of them. premiums normally paid by check can be paid The ACH is still in its infancy compared with automatically. the nation's other payment systems. And, not

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all the players agree who should operate it and and cooperation by all the players involved. Yet how it should be operated. Expanding the ACH despite such obstacles, advocates are convinced depends upon further cost reductions that that as far as payments are concerned, the only economies of scale can offer. Increased ACH is the future. use of the ACH will require general acceptance

NOTES

«Bank for International Settlement, Payment Systems in Eleven Deveh 'Atlanta Payments Project Automated Clearing Houses: An In-Depth oped Countries, Bank Administration Institute: Park Ridge, Illinois, Analysis, Committee on Paperless Entries: Atlanta Georgia, 1974, p. 13. 'NACHA Surepay Update, October/November/December 1985, p. 5. 2Ibid, p. 10. «Federal Reserve Board of Governors, 1985. These numbers differ ilbid, p. 10. significantly from those reported by NACHA in Surepay Update. as 'American Bankers Association, Report of the Automated Clearing NACHA's numbers include some double counting of interregional ACH House Task Force, American Bankers Association: Washington D.C, transactions 1974, p. 4. 'Ibid, p. 4.

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